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February 13, 2013

FINRA Warning on BDCs Doesn’t Stop Market Vectors’ ETF Debut

Market Vectors BDC Income ETF offers high yields from private or thinly traded public companies

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Flying in the face of conventional wisdom—and warnings from the Financial Industry Regulatory Authority —Market Vectors ETF Trust announced Tuesday that it is launching the first-ever exchange-traded fund to offer pure-play exposure to the high-yield, high-risk world of business development companies.

The Market Vectors BDC Income ETF (BIZD), sponsored by Van Eck Global, seeks to replicate the price and yield performance of a Market Vectors BDC index, at a net expense ratio of 7.56% and a management fee of 0.40%. The fund’s top six holdings out of 26 are the business development companies Ares Capital Corp., American Capital Ltd., Prospect Capital Corp., Apollo Investment Corp., Triangle Capital Corp. and Fifth Street Finance Corp.

“Business development companies have traditionally been high-yielding, making them an attractive choice in today’s ongoing search for income,” said Brandon Rakszawski, product manager for Market Vectors ETFs, in a statement. “Investing in BDCs provides exposure to private companies that many investors could not otherwise access, allowing for potential growth and yield generation.”

Meanwhile, FINRA stated in a Jan. 11 letter to the broker-dealer firms it oversees that it is concerned about “potentially unsuitable and otherwise problematic” investments for retail investors based on risk factors such as liquidity and credit ratings. “Business development companies earn top billing,” noted The Wall Street Journal’s Wealth Management report in a story about the FINRA letter.

The ETF’s prospectus acknowledges that “an investment in the fund involves a substantial degree of risk,” because BDCs generally invest in less mature private companies or thinly traded U.S. public companies, “which involve greater risk than well-established publicly traded companies.”

BIZD’s rules-based index intends to track the overall performance of publicly traded business development companies, rather than the companies they invest in. Market Vectors’ fact sheet for the ETF touts its “high income potential” as the only ETF offering pure-play exposure to BDCs.

How exactly do BDCs generate income? By lending to and investing in little-known companies that tend to carry below-investment-grade credit ratings—or no ratings at all. In addition, the BDCs that comprise Market Vectors’ index are expected to generate income in the form of dividends.

During the morning call introducing the ETF, Fifth Street CEO Leonard Tannenbaum acknowledged concerns around BDC risk, but he pointed to the product’s tighter leverage restrictions, now at 1:1.

“No BDC can be over-levered, which is why through the 2008-’09 financial crisis, no bank lost any money that lent to a BDC, not even the quote-unquote ‘bad players,’ and I won’t name them,” Tannenbaum said. “No debt holder lost money.”

He argued that the new Market Vectors ETF offered broad diversity within a range of companies, and added that Fifth Street Finance Corp. is rated triple B minus by Fitch and Standard & Poor's, and the leader, Ares, is rated triple B by Fitch and S&P.

“Even of the top five constituents in the index, all of us lend differently and add a different balance to the portfolio, with senior and second liens and different risk-adjusted profiles,” Tannenbaum said.